A shrinking US middle class is transforming the housing market

The divide between the rich and the poor has been widening over the past three decades. And this growing chasm is being mirrored in homeownership trends in the U.S.

John Burns Real Estate Consulting examined the state of the housing market for middle-class Americans (excluding those over the age of 65). The firm found that a shrinking middle class has led to higher demand for rentals, high-end and low-end homes, therefore less demand for median-priced homes.

Middle class is defined as those who earn between two-thirds and twice the median U.S. household income. Fifty-seven percent of American households were middle-income in 1970, compared to 45% today, representing a 12 percentage point decline. Meanwhile, there’s been a seven percentage point increase in the percentage of households that make more than double the U.S. median income (12% in 1970 to 19% in 2016) and a four percentage point increase in households who make less than 80% of the U.S. median income (31% in 1970 to 35% in 2016), according to John Burns.

Any home that falls in the bottom third price bracket is a starter home; the middle bracket is a tradeup home; the top bracket is a premium home. The exact price cut-offs depend on where the home is located.

Rental demand

More households are renting than at any point in the past 50 years. Fewer households are able to save or qualify to purchase a home, and will continue to rent in the near-term.

Rental demand “will remain strong for the foreseeable future even if the homeownership rate gradually increases, because there is still such strong demand among households who lack down payment savings to buy,” said Stockton Williams, executive director of the National Council of State Housing Agencies (NCSHA).

Even if renting provides a temporary fix, it ends up impeding the path to homeownership.

“The rental affordability challenge makes it even harder to save up for a down payment if you’re wasting money. This is especially frustrating for aspiring first-time homebuyers who are dedicating more of their income to pay rent every month,” said Lisa Sturtevant, The Urban Land Institute’s visiting fellow for housing.

The dumbbell effect

Corresponding to a shrinking middle class, there is also less demand for homes that are in the middle of the market. The cheapest homes in the U.S. are seeing the most demand, and the months of supply and days on market for these properties are extremely low, according to John Burns.

According to Williams, homebuilders are starting to turn their attention to building starter homes. Citing D.R. Horton (DHI), Tri Pointe (TPH) and Meritage (MTH), he said that large players are doubling down on entry-level options that “may be serving families at the middle as well as the lower end of the home buying market,” he said.

For the lower income folks, Williams suggests “low-interest mortgages coupled with down payment assistance from state housing finance agencies” as a solution.

As a larger share of households rise into the upper-income brackets, and are “buying later in life due to delays in marriage and having children,” more households are buying pricier-than-usual first-time homes. John Burns points out that this isn’t happening in the ultra-high price points, but in homes priced up to 50% higher than the median home price in a market.

“Home builders in particular have benefitted from this demand, selling higher-density new homes in great locations to first-time buyers.”

Most new homes built since the end of the recession have catered to the higher end of the market because of the strong demand. But, more recently, a growing number of builders have recognized the significant pent up demand in the middle of the market. “Even if it is shrinking relative to other income segments, it remains significant in size and underserved in many parts of the country,” said Williams.

Melody Hahm is a senior writer at Yahoo Finance, covering entrepreneurship, technology and real estate.Follow her on Twitter @melodyhahm.